Are Stock Acquirers Overvalued? Evidence from Short Selling Activity

We use a novel identification approach to test whether stock acquirers are overvalued prior to merger announcements or whether they have high growth opportunities (Q-theory). We argue that the overvaluation of firms drives both high short selling activity and a higher likelihood of stock mergers. We document that, as early as 12 months before a merger announcement, short selling activity is higher (lower) for firms that eventually make stock (cash) acquisitions. High short interest predicts long-term negative returns following the announcement. Finally, stock (but not cash) acquirers have higher short interest than their targets. We investigate alternative explanations for our results that do not assume short sellers only target overvalued firms and show that these explanations do not appear to explain our results. We conclude that overvalued firms self-select to become stock acquirers and that short selling activity does not completely eliminate acquirer overvaluation.